Borrowing from 401(k) can be easy, but costly

Your 401(k) or 403(b) savings are meant for retirement. But if you're scraping together a down payment for a home or the old car is set to expire, you could borrow from your 401(k) for these short-term needs.

Most employers--85 percent, according to the Profit Sharing/401k Council of America, a non-profit association of companies and plan participants--allow workers to take a 401(k) loan. Roughly a quarter of employees who are eligible to borrow take out a loan.

Granted, when you pay interest on a loan from your 401(k) it's deposited in your account, not a bank's coffers. Generally, the rate is based on the prime rate, currently 8.25 percent, plus 1 or 2 percentage points.

That's a sizable rate, and were you to time the withdrawal before a downturn in the market, you could come out ahead.

"If you took out a loan at the beginning of 2000, that worked out very well for you," said Frank Moore, a financial planner in Ann Arbor, Mich. "But you typically don't get that lucky."

In fact, you could remove your money just as the market is poised for a significant upswing.

In 2006, for example, the benchmark Standard & Poor's 500 index had a total return of 15.8 percent.

Beyond mathematics, though, there are a few other reasons why you shouldn't touch this money, no matter how tempting.

For one, your 401(k) is for your retirement. And, given pessimism about the future of Social Security and Medicare, it seems like one of the few resources that today's twentysomethings are going to have in old age.

Second, though companies make it easy to borrow the cash, the repayment terms can be less accommodating.

You generally have five years to repay the loan (or up to 15 years if the loan is used to purchase a home).

But quit your job and, in most cases, you have only 60 days to pay off the remaining balance.

"Most employers don't want to process check payments after you leave," said Rick Meigs, president of 401khelpcenter.com. Payments typically are deducted automatically from your paycheck.

If you can't cover the balance and you're younger than age 591/2, the loan is considered an early withdrawal. As a result, you will owe federal and state income taxes, plus a 10 percent penalty to Uncle Sam.

All told, the final tax bill is often some 40 percent of the balance.

"The single major concern is that people enter the loan arrangement without realizing they've obligated themselves to this repayment," Wray said.

-- Finding cash elsewhere

Where can you find the money?

Financial planners often point to traditional sources such as an auto loan over your 401(k).

If you're a homeowner, you also could consider a home-equity line of credit (though, of course, you don't want to borrow too much of your home's value and risk owing the bank when you go to sell).

There's no easy answer. Just remember that in retirement, you'll probably be grateful for every penny in your 401(k).

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